December 12, 2017 | Posted in:

Know Your Limits: How to Fix an Overfunded Retirement Account

Is stashing away large sums in a tax-deferred retirement account ever a bad idea? According to CPAs, it is when you exceed the annual IRS limits. Intentional or not, the penalties can be painful. Here’s how overfunding occurs and what steps you can take to correct the problem.


When do overfunding situations occur?

Overfunding retirement accounts happens more than you may realize. It can be the result of a job change that causes you to participate in the two different employer retirement plans. Sometimes people forget they made IRA contributions early in the year and do it again later. Others forget that the IRA limit is the total of all accounts, not per account. The rules are complicated. Traditional IRAs can’t be contributed to after age 70½, while Roth IRA contributions are subject to income limits. Plus all contributions are predicated on having earned income.


“Automatic monthly contributions are a great way to save regularly,” explains Julie Strohlein, CPA.  “They are also easy to forget about since they are set up once and then occur without additional action.  If you were able to contribute to a Roth IRA in the past, and you set up a monthly withdrawal, you may forget to turn it off as soon as your annual income exceeds the limit.  In fact, it might be months later when your tax return is being prepared in the spring that the overfunding is noticed.  By then, the overfunding has crossed into a second tax year.”



The annual Roth and Traditional IRA contribution limit is $5,500 ($6,500 if age 50 or older). If you surpass this amount, you pay a 6 percent penalty on the overpayment every year until it’s corrected, plus a potential 10 percent penalty on the investment income attributed to the overfunded amount.


The Fix: If the overfunding is discovered before the filing deadline (plus extensions), you can withdraw the excess and any income earned on the contribution to avoid the 6 percent penalty. You will potentially owe 10 percent on the earnings of the excess contributions if you’re under age 59½. You can apply the withdrawn contribution to the next year. If your issue is due to age (70½ or older for a Traditional IRA) or income limit (for a Roth IRA), consider recharacterizing your contribution from one IRA type to another.


“If the problem is discovered in April, you might want to extend your tax return so that you have time to sort everything out and get the money back before filing your return.” – Julie



The rules for correcting an overfunded 401(k) are a little more rigid. You have until April 15 to return the funds, period. The nature of the penalty is also different. The excess amount is taxable in the year of the overfunding, plus taxable again when withdrawn. So, you pay tax twice on the same amount. And in certain cases, overfunding a 401(k) could cause it to lose its qualified status.


“If you don’t change employers, there are often safeguards in the payroll software to prevent overfunding a 401(k),” adds Julie.  “When you change jobs, however, the new employer has no idea how much you contributed while at your former job.  Make sure you know the total amount before filling out the contribution paperwork at the new job.”


No matter the cause, if you are in doubt about how to handle excess contributions, give Alloy Silverstein a call.
The information contained in this newsletter is of a general nature and should not be acted upon in your specific situation without further details and/or professional assistance. For more information or for assistance with any of your tax or business concerns, contact our office at 856.667.4100.


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